Circular of CBDT on Section 14A too much delayed and an afterthought in a half hearted and prejudiced manner – section 14A should apply when any income is not taxed directly or indirectly like agricultural income or interest on tax free investments or securities.

[CA DEV KUMAR KOTHARI]

References and links:

Commissioner Of Income-Tax, Madras Versus Indian Bank Limited Dated - 26 October 1964 1964 (10) TMI 14 - SUPREME COURT other Citation: [1965] 56 ITR 77

Circular No 5-dated 11.2.2014.

Some of important cases which lead to insertion of S. 14A

Commissioner Of Income-Tax, Madras Versus Indian Bank Limited Dated - 26 October 1964 1964 (10) TMI 14 - SUPREME COURT other Citation: [1965] 56 ITR 77

Commissioner of Income-Tax, Bombay City I Versus Maharashtra Sugar Mills Limited Dated - 16 August 1971, 1971 (8) TMI 14 - SUPREME Court Other Citation: [1971] 82 ITR 452 (SC).

Rajasthan State Warehousing Corporation Versus Commissioner of Income-Tax Dated - 23 February 2000, 2000 (2) TMI 5 - SUPREME Court Other Citation: [2000] 242 ITR 450 (SC)

Case of Indian Bank:

Before discussing section 14A, Rule 8D and recent circular of the CBDT it is necessary to refer to certain judgments which lead to insertion of S.14A.

The case of Indian Bank (supra.) was finally decided by the Supreme Court on 26^th October, 1964 in relation to assessment year 1951-52, for which previous year was accounting year being calendar year ended 31^st December 1950. In this case the Tribunal has taken a view in favor of revenue by confirming disallowance of proportionate interest expenses in relation to income claimed to be exempted income. However, on appeal of assessee bank, the High Court decided the issue in favor of assessee holding that entire interest paid was allowable. On appeal the Supreme Court affirmed the view taken by the High Court holding that interest was paid on capital borrowed by assessee for the purposes of its business and therefore full amount of interest was allowable.

In other two cases referred to above, the rule laid down in Indian Bank was applied.

Section 14A inserted with retrospective effect:

Section 14A was inserted by the Finance Act, 2001 with retrospective effect from 01.04.1962 to overcome ruling in Indian Bank and some other judgments on similar issue.

Therefore, insertion of S. 14A was more than 50 years from the relevant accounting year of Indian Bank and more than 36 years after the final ruling rendered on 26.10.1964 by the Supreme Court. Therefore, if we consider the date of judgment vis a vis effective date, it can be said that the judgment dt. 26.10.1964 is also affected as it is after the effective date. However, the amendment cannot affect the impact of the ruling because the dispute related to assessment year 1951-52 which is prior to the date of coming into force of new section 14A that is w.r.e.f. 01.04.1961.

How legislative intention has been ascertained in 2001?:

The question which arises is, how legislative intention which prevailed earlier, has been ascertained (rather say re ascertained) during year 2001?

When the Supreme Court has interpreted the provisions and ascertained legislative intention in 1964, how such legislative intention which prevailed even after the judgment of the Supreme Court for more than 36 years could be re ascertained?

To examine whether it is legislative intention , in view of author we need to examine the following:

Legislative intention when old provisions were made in the Income-tax Act, 1921 and similar provisions in the Income-tax Act, 1961 on the related matters.

The composition of legislators at different times – 1921, 1961, 2001.

Clarification and discussions amongst the legislators on the subject of old provisions, new

provisions, the difference, and reasons for amendment and reason for application of amendment with retrospective effect.  

Answer to question as to why not an amendment was made soon after judgment of the Supreme Court in the case of Indian Bank in 1964, particularly when we find yearly amendments in the Act and many other amendment in the Act between 1964 - 2001.

If all above aspects can be examined, it will lead to only one conclusion that the amendment is not result of legislative intentions but is a result of bureaucratic whims of the draftsman and field force of Income-tax Department.

Half hearted approach of the CBDT in its latest circular dt. 11.02.2014:

It appears that the honorable Board has applied half hearted approach to interpret S.14A by using the language used in it to hold its own view and by not applying the language used in the section in overall context of the provisions of the Income-tax Act, 1961.    

In the circular the Board has emphasized on the following words used in heading and provisions of S. 14A and Rule 8D:

From circular	Comments of author
term "includible" in the heading to section 14A	In fact phrase ‘not includible’ has been used.
term "includible" in the heading of Rule 8D also.	In fact phrase ‘not includible’ has been used.
does not use the word "income of the year" But words used are "income under the Act".	The Board has considered these words to signify that if income is exempt in any year or will be exempt in future then also S.14A will apply. In fact, significance of the words "income under the Act" has been wrongly applied by the Board. The section will apply only if income is not at all taxable income under the Act. This aspect has not been considered by honorable Board.

The Board has opined that “ in light of the above, CBDT in exercise of its power under section 119 of the Act hereby clarifies that Rule 8D r.w.s section 14A of the Act provides for disallowance of the expenditure even where taxpayer in particular year has not earned any exempt income”.

What has been ignored by honorable Board?

With due respect and regard the author feels that the honorable Board has ignored different vital phrases used in section 14A. The section, as it stand now, is reproduced, with highlights of vital phrases used in it:

[Expenditure incurred in relation to income not includible in total income.

14A.[(1)] For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.]

(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.

(3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act :

Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001.

 We find two sets of wordings used in the section which are given in first column and in second column significance is discussed:

Words used	Significance and discussion in light of Circular
total income under this Chapter,	This expression is used in relation to total income of assessee which is computed as per provisions of the Chapter IV that is Sections 14- 59. The income of assessee is always computed for a particular year. Therefore, what is relevant for the year in hand is relevant and past and future years may not be relevant.
in relation to income which does not form part of the total income under this Act.	Here ‘total income under this Act’ means income in overall context of the Act and not confined to income computed for any assessee. Here the language used is to cover only such income which is not at all taxable under the Act. or income which does not form part of chargeable income in any manner, on which tax   in nature of tax on income is imposed under the entire Act whether directly or indirectly.
The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act	The AO can determine disallowable expenditure only when any ‘income does not form part of total income under the Act’ and not merely when any income is not included in total income of assessee while computing income under Chapter IV.
expenditure in relation to income which does not form part of the total income under this Act.	The disallowable expenditure concerns income which does not form part of the total income under the Act, and not merely under Chapter IV
no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act :	Here also income which does not form part of the total income under this Act is relevant and not merely income which is not included in income of assessee while computing his income under Chapter IV.

The honorable Board has considered the words ‘total income under the Act’ to signify that it will cover such income even if there is no income during any particular year. With respect author conveys that this is patently wrong approach of the Board.

In fact from above analysis ‘total income under the Act’ means that it is clear that S.14A will apply only to such incomes which are not chargeable at all under the Act.

If it was intended only in relation to the assessee whose income is to be computed, then similar expression could have been used that is ‘which does not form part of total income under this chapter or ‘which does not form part of total income of assessee’ instead of words ‘which does not form part of the total income under this Act.

The Income tax Act is a self contained and integrated code. As per scheme of the Act, some incomes are taxable in hands of the recipient of income whereas some incomes are taxable in hands of person who pays or distribute income. When a tax is finally collected (that is not in nature of tax deducted or collected on behalf of recipient of income) at distribution stage, then the income-tax in respect of which such tax is collected is a taxable income, and tax so collected is nothing but tax on income or tax in lieu of income-tax payable by recipient of such income. Therefore, it cannot be said that such income does not form part of total income under this Act.

Once it is found that dividend forms part of ‘total income under this Act’, and a taxable income is computed, and tax is imposed and collected u/s 115 O and 115 R, then S.14A will not at all be applicable in relation to such income which has already been include in taxable income in some other scheme of imposing tax on income.  

Similarly income received by partners of firm, or members of AOP, on which the firm or AOP has already been assessed and firm or AOP has already paid tax, then the amount received by partners or members from such income is an income which has formed ‘total income’ under the Act and tax has been paid on such income. Therefore, S. 14A shall not apply to such income in hands of partner or member.

Therefore, section 14A is applicable only in relation to income which does not form part of the total income (that is chargeable income) under the Act in any hands (not necessarily in hands of recipient of income or assessee). The expression ‘total income under the Act’, in this context can only mean, income chargeable to tax in one or other manner under the Act and even under some other scheme of taxation of tax on income.

Simplified taxation schemes:

The scheme of tax on distributed income by way of dividend by companies and mutual fund was brought on statute book for simplification of imposition and collection of tax. Dividend is exempted in hands of share holder or unit holder only when a tax has been imposed u/s 115 O or 115R.

Similarly tax on income by way of security transactions tax (STT) was brought for simplification of tax on income in security transactions.   STT is also a finally collected tax in lieu of income-tax. Therefore, income by way of long-term capital gains in certain transactions has been exempted when STT has been levied.

Therefore, it cannot be said that dividend covered by S. 115 O and 115R are exempted under the Act. Similarly Long-term capital gains cannot be called as exempted income.

Income which can be subjected to S.14A:

In view of author, only incomes which are not at all taxable directly or indirectly cab be subjected to S. 14A for example agricultural income, interest on PPF, interest on tax free securities (without reduction in rate of interest in comparison of taxable securities), interest on other investments, income of certain institutions, which are exempted and does not bear tax by way of tax on income in any other manner. Readers can also refer to other articles on section 14A on this website.